Structural Reforms Can Help Japan’s Post-Consumption Tax Blues

IMF Blog, August 14, 2014

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Japan’s GDP declined by almost 7 percent in the second quarter.
The consumption tax increase this April contributed to the decline, but it is not the full story; large spending swings following major tax increases are common (example cited: Germany’s 2007 VAT increase had a short-lived impact).
With the near-term outlook increasingly uncertain, faster progress on structural reforms—the third arrow of Abenomics—is essential to lift expectations and maintain confidence.

Abenomics has made progress in ending deflation and jumpstarting the economy.
Recent IMF staff research shows firms need clarity about future growth opportunities before they start to invest.
Faster implementation and a more comprehensive approach to structural measures are needed to lift expectations and encourage investment.

Over the last decade, Japan’s average ratio of cash holdings relative to market capitalization exceeded 40 percent.
This ratio is more than double the equivalent figure for many other G-7 countries.
IMF staff research suggests governance and legal framework reforms could lead to more efficient use of these resources.
- Measures cited: raising the number of external independent directors; adoption of a corporate governance code for firms.
- Empirical evidence: firms with many external directors rarely hold large cash reserves.
- Recent steps already taken: amendments to the Company Act and introduction of a Stewardship Code for institutional investors.

Shortages in Japan’s labor market are becoming a growth bottleneck due to an aging population, limited access to foreign workers, and rising demand for skill-intensive services (especially in health).
Japan’s segmented labor market (regular lifetime employment vs. rising irregular employment) reduces productivity growth and labor attachment for many, including highly educated women and younger workers.
Narrowing differences between regular and irregular employment could reduce inefficiencies and help reallocate talent to where it is needed most.
There are no easy fixes, but addressing labor market rigidities would enhance growth potential.

Japan’s public-debt-to GDP ratio is at over 240 percent of GDP.
The consumption tax rate increase to 10 percent (this and next year) would reduce the deficit by about 2 percent of GDP—an important down payment toward restoring fiscal sustainability.
A still sizeable future consolidation need of another 6 percent of GDP remains, leaving fiscal risks large.
Recommendation: adopt a concrete fiscal strategy beyond 2015 to limit risks of a sudden rise in interest rates and allow flexible responses to downside risks.
On monetary policy:
- The Bank of Japan has made great strides in ending deflation; inflation and inflation expectations are increasing.
- Real interest rates are declining and lifting returns on capital investments.
- The IMF view: the Bank of Japan’s easing policy is appropriately accommodative now; if progress in raising inflation stalls, it should act swiftly and expand its asset purchases.

Speed up implementation of structural reforms (third arrow of Abenomics) to lift expectations and confidence.
Reform corporate governance and legal frameworks to encourage firms to deploy large cash holdings productively (e.g., more external independent directors; corporate governance code).
Address labor market duality to increase labor supply and productivity, especially for highly educated women and younger workers.
Adopt a concrete fiscal strategy beyond 2015 to manage the high public-debt-to GDP ratio and the remaining 6 percent of GDP consolidation need.
Maintain accommodative monetary policy and be prepared to expand asset purchases if inflation progress stalls.

Source: Structural Reforms Can Help Japan’s Post-Consumption Tax Blues — Stephan Danninger, August 14, 2014.

構造改革は、日本の消費税引き上げ後の憂鬱感を解消するのに役立つ, ステファン・ダニンガー, iMFdirect ブログ 2014年8月14日掲
- 構造改革は、日本の消費税引き上げ後の憂鬱感を解消するのに役立つ, ステファン・ダニンガー, iMFdirect ブログ 2014年8月14日掲 (Markdown version)
- 構造改革は、日本の消費税引き上げ後の憂鬱感を解消するのに役立つ, ステファン・ダニンガー, iMFdirect ブログ 2014年8月14日掲 (PDF)